The story of the Indian economy in 2014 could be played out in two acts. The event to divide the next year into two halves will be the result of the coming general election.

Meanwhile, US Federal Reserve chairman Ben Bernanke removed one source of uncertainty when he said on 19 December that the US central bank would begin to trim the pace at which it has been buying bonds to create new money. He has balanced that with unusually strong guidance that the US would continue to follow an accommodative monetary policy for a long time. The taper of quantitative easing is scheduled to begin in January.

The domestic economic situation is not a pretty picture: there is no growth recovery in sight even as consumer price inflation continues to hover around double digits. So there is little room for a stimulus to economic activity right now.

A monetary stimulus will be risky at a time when the Reserve Bank of India (RBI) has to douse the inflationary fires that were left unattended for too long. A couple of more interest rate hikes in the coming months are quite possible, despite the surprise decision by the Indian central bank to press the snooze button in December.

A fiscal stimulus will also be fraught with risks. The finance ministry is struggling to keep the fiscal deficit within its budgeted figure, especially since tax revenues have fallen behind targets because of the growth slowdown. So the finance ministry has been trying to compress expenditure.

The government can at best try to ease the economic situation through executive decisions to thaw large investment projects that have been frozen because of the regulatory climate.

A lot depends on how the Congress party interprets the results of the recent state elections when it got trounced. One possibility is that the party may see voter dissatisfaction as a response to high inflation. Then there are good chances that its government will cooperate with the Indian central bank in keeping a lid on domestic demand, with a combination of higher interest rates and lower government spending.

The other possibility is that the political leadership may see the loss of economic momentum as the major reason for the voter revolt, in which case it could be tempted to pour money into populist schemes that it believes could win votes.

There are two interesting lessons from recent history. The P.V. Narasimha Rao government went to the polls in 1996 in the midst of a brutal monetary compression engineered by RBI in a bid to slay the inflation dragon. Rao lost the election. The first Manmohan Singh government prepared for the 2009 elections with a big increase in the fiscal deficit in its last proper budget, presented in March 2008. It waived farmer loans and ramped up spending on the rural jobs scheme. The government was voted back to power.

This simple history lesson as well as the basic political instincts of the Congress leadership would suggest that the current government may yet be tempted to throw fiscal caution to the winds despite the persistence of high inflation.

But while the political incentives are aligned in favour of fiscal profligacy—and there is also empirical evidence of such behaviour evident in the research on political business cycles—there is a complication. The economic situation right now is dramatically different from that in early 2008. Global investors will not be impressed if India lets its fiscal deficit overshoot the budgeted target or allows inflation to further drift up. Nor will global credit agencies be cheering from the sidelines.

There are glimmers of hope, however. The current account deficit has thankfully shrunk because of administrative measures to compress gold imports as well as more robust export growth following the depreciation of the rupee, though India will still be dependent on strong inflows of portfolio capital to fund its current account gap.

India has also managed to rebuild the reserves it lost during the defence of the rupee in July and August, thanks to the attractive swap offered to banks for non-resident deposits as well as some buying of dollars from the market.

So the Indian economy seems to be in a better position than a few months ago to handle the aftermath of a new round of instability in the global financial markets. But it would also be useful to remember that the policies that have helped reduce the current account deficit and rebuild reserves will have to be phased out. A persistent attempt to curb gold imports will breathe life into the moribund smuggling trade, while attractive swap rates for dollar deposits will attract arbitrage capital.

Policymakers in New Delhi and Mumbai have done well to ensure that India is in a better position to deal with global volatility than it was in July. However, the big worry is whether India can maintain external stability without such artificial props.

There are good reasons why Bernanke has decided to finally cut the pace of reserve money creation. The latest output and employment data from the US show that the recovery in the world’s largest economy is getting consolidated. The latest numbers on composite leading indicators by the Organization for Economic Co-operation and Development (OECD) suggests that there could be a synchronized recovery in the developed countries in 2014. The leading indicators usually give a good idea of the actual economic situation six months ahead, so the December numbers put out by OECD suggest that the developed economies could be in better shape by the middle of 2014.

A synchronized global recovery will offer one opportunity to India, especially when the rupee is now less overvalued than before. Strong global demand will mean that the recent recovery in exports could stay the course, no small matter at a time when the other major engines of economic growth—consumer spending, capital expenditure and government spending—are stuttering. Strong export growth will be welcome in such a situation.

Yet, India is not totally out of the woods. The current confidence in the economic policy establishment that the worst is over could be severely tested in the middle of 2014, especially if the national elections throw up a confused mandate as well.

That will be as far as the first half goes. What happens over the second half of 2014 will depend a lot on what the results of the national elections are.

The new government will inherit an economic mess. It will have to set its fiscal house in order, keep its eye on inflation, rebuild confidence, push a new reforms agenda and get investment activity in the private sector off the track. It will not be an easy task—and much will depend on the nature of the mandate—who comes to power and what are the chances of the next coalition lasting the five-year course?